The Evolution of Money

by David Orrell

  The castles eventually morphed into banks for the nobility. At its peak, the group had 870 “branches” and employed about 7,000 people.12 However, their success soon turned them into a target for the state. When debasing the currency by 75 percent didn’t solve his financial problems, King Philip IV cracked down on the Knights Templar, sentencing their leaders to death and confiscating their immense riches.

  Apart from the Crusades, another expense that was stretching the finances of the Church was the building of magnificently expensive cathedrals. Notre-Dame in Paris, for example, was paid for by a combination of grants from the Church, bequests from rich bishops and burgesses, and a head tax known as the taille. Many towns such as Amiens took out large loans to finance their building. Construction often went on for centuries; in part this was because financing was sporadic, but it also tells us something about the attitude toward money in the Middle Ages. Most modern governments, obsessed as they are with the scarcity of money, would be loathe to commit to such enormous projects that stretched over generations—even if they did promise an enormous payoff in the long run. Cathedrals were the tourist attractions of the day, attracting huge numbers of pilgrims, and even today they continue to boost their local economies.

  One reason for the more relaxed attitude toward timescales was that usury was considered a sin, so in principle at least there was less hurry to pay debts. The main argument against usury was that it was considered to be a form of the mortal sin of avarice; however, it was also considered to be a type of theft—of time. Usury made money out of the time it took to repay a loan, and time—including the time it took to build a cathedral—belonged only to God.

  A similar argument, interestingly, was levied against intellectuals and teachers who took on students in return for payment. As Saint Bernard noted, such people were “sellers and merchants of words”—and knowledge, like time, was the property of God.13 Partly in response, intellectuals organized themselves into that new institution known as the university. These provided academics with a reasonable standard of living, while allowing them to distance themselves from the need to charge fees. The first recognized universities were in Bologna (1088), Paris (ca. 1150), and Oxford (1167). At the center of the university curriculum were the works of Aristotle. A Paris-based school of economic thought, known today as Scholastic economics, aimed to reconcile Aristotle’s ideas about money and property with Christian theology.

  As with Aristotle, money was seen as no more than a social convention, which certainly made sense in an era when most transactions were carried out without the use of coins.14 According to Aristotle, monetary profit of any kind amounted to theft, and “the most hated sort, and with the greatest reason, is usury, which makes a gain out of money itself, and not from the natural object of it. For money was intended to be used in exchange, but not to increase at interest. And this term interest, which means the birth of money from money, is applied to the breeding of money because the offspring resembles the parent. Wherefore of all modes of getting wealth this is the most unnatural.”15

  The synthesis of Aristotelian and Christian doctrines reached its highest point with the Dominican friar Thomas Aquinas, who taught in Paris and Cologne. According to Aquinas, money was “the one thing by which everything should be measured.”16 Money was seen not as an end in itself—the pursuit of wealth was un-Christian—but “was invented chiefly for the purpose of exchange.” The most important virtue, and the glue that held society together, was caritas (charity), which was an expression of love.

  Aquinas put great emphasis on the rationality of Greek philosophy and agreed with the ancient Greeks that man was a “rational animal.” His concept of a “just price” corresponded to the conventionally accepted price that would hold when neither the buyer nor the seller was under duress. Aquinas allowed that the price for a good could be agreed between two parties by haggling, but it was unjust for one party to take advantage of the other—for example, by charging a starving person more during a famine. Economics (the name had not yet been invented) was therefore part of a larger framework based on ethics and rationality.

  The root of the word “rationality” is the Latin word ratio, which refers to both reason and calculation. Aquinas and the Scholastics may have emphasized the former, but money was all about the latter. As historian Jacques Le Goff points out, “Money was a tool of rationalization,” and its growing use would have profound effects on the medieval mind-set.17

  Arte de Cambio

  The discovery of new mines, along with technical improvements in minting, led to a spread in the use of metal money during the thirteenth century. Perhaps counterintuitively, this increase in money supply was accompanied by a huge rise in indebtedness for all classes of society, but especially the peasantry. One reason was that institutions, including the Church and nascent states, with their growing demands for taxation, began to demand payment in coin rather than in produce or a set number of days of labor.18 Society was once again aligning itself with the pull of money.

  The rise in indebtedness made moneylending a very profitable activity—in this world at least, if not the next. While it was taboo for Christians to lend money for interest—in his Inferno, the Italian poet Dante Alighieri described usurers’ existence in the seventh circle of hell, and it didn’t make for easy reading—no such restriction applied to Jews, with the result that Jewish communities became the financial services centers of their time. But as the economy grew in size, and money played a more important role, a wider debate began in the universities and elsewhere about the restrictions on usury.

  One argument in favor of the practice was that the interest charged on a loan was compensation for the risk of not being repaid. Another was that the interest represented payment for a kind of opportunity cost, since the money loaned could not be put to another use. And finally, there was the idea of justice: like anything else, money should surely have a just price (typical rates at the time were actually around 20 percent, which is high by our standards).19 Therefore, while theologians continued to condemn usury, it gradually became more acceptable in practice to introduce charges for loans. In Italy, for example, Christian moneylenders would loan money for free but insisted that the debtor pay insurance against default, rather like a modern credit default swap. The growing link between time and money was mirrored by the development of mechanical clocks, which originated as a prompt for bell ringers in monasteries and cathedrals but were soon put to use in regulating the workday.

  The economy was also becoming increasingly complex, as the manufacture of crafts was broken up into specialized trades and guilds—many of which were reflected in surnames such as Smith in English and Schmitt in German—and businesspeople formed themselves into associations that later became known as companies. In response to the growing need for finance, moneylenders and changers themselves evolved into the precursors of modern insurance companies and banks.20 The nascent financial industry was centered in the major northern trading cities of Italy, such as Venice, Genoa, and Florence. These cities had become wealthy through trade with Asia in goods such as silks and spices, which was carried out along the famous 4,000-mile caravan track known as the Silk Road. Unlike the now-defunct Knights Templar, the new banks catered not just to nobility or the church but also to the needs of landlords, vendors, and merchants like the fictional Antonio in William Shakespeare’s The Merchant of Venice (Elizabethan playwrights were beginning to incorporate money into their works). Expansions in trade meant that merchants had to borrow money to finance their expeditions, and moneychangers, who had their own guild called the Arte de Cambio, did a thriving trade swapping between the multiplicity of coins available.

  Money for Nothing

  When the Venetian explorer Marco Polo returned from China in 1295 via the Silk Road, one of the many marvels he described was how the government of Kublai Khan had compelled the Chinese population to accept money made from sheets of paper, signed and stamped with the royal seal, instead of metal (part of
the trick was that counterfeiters were put to death). As he noted: “All these pieces of paper are, issued with as much solemnity and authority as if they were of pure gold or silver … everybody takes them readily, for wheresoever a person may go throughout the Great Kaan’s dominions he shall find these pieces of paper current, and shall be able to transact all sales and purchases of goods by means of them just as well as if they were coins of pure gold.” The scheme was very successful—the Chinese economy was thriving at the time—and of course it meant that the government could hang on to its silver and gold instead of releasing it as currency. Damaged notes could be returned to the mint, where they were replaced for a charge of 3 percent (a kind of negative interest).21

  Inspired by this example, European bankers and goldsmiths (who needed a working supply of gold) began issuing paper promissory notes in exchange for deposits that were payable to anyone who had them in their possession. The notes could therefore be traded, rather like the banknotes of today (the term originates from the fourteenth-century nota di banco). The innovation that really disrupted the existing money system, however, was the bill of exchange. These were essentially letters instructing a banker or an agent in another country to make a payment on the writer’s behalf. For example, suppose a merchant in Venice wanted to import some goods from a supplier in France. He could purchase a bill of exchange, paid for in coins (or on credit), that allowed him to withdraw the same amount, at a set exchange rate, from a bank or an agent in France.

  The banker’s fee, of around 10 percent, would be incorporated into the exchange rate. In fact, the amount of the bill was usually denominated in virtual units of account such as sous, or the imaginary unit known as the écu de marc. This acted as a kind of single, unifying money for all the different moneys and meant there would be two exchange rates, one for each of the real currencies. Unlike checks, which didn’t appear until the late fourteenth century, bills of exchange could be deposited or cashed only in person. Since the bill represented a loan for a certain time, the commission included what amounted to an interest charge.

  The main advantage of bills of exchange was that they allowed international business to be carried out without having to deal with coins. These were slow to transport (it could take a month to move a stash a few hundred miles), easily stolen en route, and expensive to exchange. Coins were also often of questionable quality and were subject to clipping or devaluations. (In 1529, when Francis I of France paid 12 million escudos to ransom his two sons who had been substituted for him as hostages after his capture, it took the Spanish four months to count and test the coins, and 40,000 coins were rejected.)22 As discussed later, similar arguments are today made for cybercurrencies such as Bitcoin—the écu de marc of our time—which sidestep government currencies and radically reduce the cost of international currency transfers.

  Bills of exchange soon became the favored payment system for the emerging class of European merchants who needed to make international transactions. Huge trade fairs, such as the one in Lyon that happened each quarter, could be carried out almost without the need for sovereign coin.23 Once the trading had been completed, the bankers would huddle together to reconcile their books, agree on a set of exchange rates, and settle outstanding balances. The bankers would also trade the bills between themselves to balance their obligations in different currencies. If someone were short of cash, he could borrow some by selling a bill of exchange, drawn on himself and payable at the next fair. In practice, this amounted to a loan with the effective interest rate of around 2 to 3 percent per quarter.24 The currency exchange aspect offered many opportunities for speculation, especially during times of war when currencies were unstable.

  By arranging their affairs in this way, bankers were collectively acting as a central node between buyers and sellers and creating a mechanism for the creation and transmission of money. A merchant’s credit with his local banker was transferred into a bill of exchange that represented a temporary loan. Because it could be traded between bankers, it was a money object in its own right, though only within this private system. As with many other forms of financial innovation, a side effect of the use of bills of exchange was therefore an expansion in the money supply. The bills also boosted the circulation of money by substituting written letters for real coins and putting money to use in new ways. In 1317, for example, the pope arranged for money collected from Catholic churches in England to be deposited with the local London representatives of the Florentine banks of Peruzzi and Bardi. The bankers shipped a bill of exchange to the banks in Italy, which paid the pope in cash but used the deposits in London to buy English woolen garments, which they sent to merchants in Europe. Money was effectively circulating between London and the Continent, but the actual cash did not need to cross the channel.25

  Trust

  As discussed in chapter 2, money objects have the special property that their market value is defined to be equal to their numerical price. The price of gold in dollars goes up and down, but a dollar is a constant unit. This relationship is enforced by the issuing authority, so it relies on both power and its more passive relative, trust. This is especially true for virtual currencies, since an IOU has value only if the creditor knows the debt will be repaid. In ancient Mesopotamia, the primary creditor and backer of the system was the government. In the Middle Ages, the bill of exchange payment system was run by bankers. As mentioned earlier, part of the latter’s attraction was that it bypassed to an extent the use of national currencies, which were liable to be debased at any time in order to pay off some royal debt. Trust was therefore provided not by the endorsement of a government but by the mutual support of the banking network.

  Another feature of an IOU, such as a loan or bill of exchange, is that it has a time dependence. Cash is ready right now, but an IOU is a promise to repay at some time in the future. Again, this is related to the issue of trust, since the longer the time period, the more likely it is that something can go wrong. Banks, then as now, also have to balance the needs of long-term borrowers, such as mortgage holders, with depositors who might want their money back at any time. As discussed in chapter 1, one of the defining features of money is that it acts as a store of value over time and place. In a bullion-based currency, this feature is provided by both the inherent worth of the coin and the sovereign’s stamp. In a virtual instrument such as the bill of exchange, it is the centralized banking system that holds and maintains value. With cybercurrencies, trust is maintained by a decentralized network of users in concert with a defined computer protocol.

  The bill of exchange system worked because, unlike merchants, bankers were part of a small clique who knew each other personally or through reputation. Their money network was a private network that operated in a kind of shadow economy. It was controlled by an exclusive and secretive elite and was resistant to both competition or government interference. As head Jesuit Diego Laynez noted in the sixteenth century, the merchants and bankers “have so many tricks for inventing ingenious practices that we can hardly see what is going on at the bottom of it all.”26 However, the need for exclusivity also limited the network’s power and meant that the sovereign maintained the upper hand over monetary matters—at least for a while.

  New currencies often become popular when the state loses its financial authority and trustworthiness, as during the collapse of Soviet Union, when around 40 percent of company debts were handled through thousands of private systems;27 or following the 2012/2013 Cypriot financial crisis, when government confiscation of savings accounts suddenly boosted interest in alternative currencies. Rather like modern cybercurrencies, bills of exchange represented a new type of money object that offered direct competition to conventional money and allowed merchants to operate semi-independently of debt-laden and financially unreliable monarchs. The role of private banks in the parallel payment system naturally made them important economic players and was the start of a shift in power from the state to the private sector. The state could (and did) try to regu
late the system, but as discussed in the next chapter, sovereign money and private money only reached an accommodation with the founding of the Bank of England, which effectively bundled them together and shared the proceeds.

  The Rise of the Bankers

  As the feudal system broke down with the spreading use of money, so did people’s connection with the land and, therefore, the organizing principle of society. In England, for example, tenants were increasingly evicted from common land as part of the privatization process known as enclosure (a similar process is at work today as wealthy hedge funds or national governments take over arable land around the world).28 Soldiers and serfs were paid in cash instead of produce. Rather than live off their lands, feudal lords could live as rentiers in cities such as Paris (whose population in the fourteenth century reached 250,000, before the plague arrived), while investing their capital in business, city bonds, or real estate.29 As Marx later wrote, “The medieval proverb nulle terre sans seigneur [There is no land without its lord] is thereby replaced by that other proverb, l’argent n’a pas de maître [Money knows no master], wherein is expressed the complete domination of dead matter over man.”30